Dissecting Warren Buffett

CNBC: So again, Warren, we're thrilled to have you here this morning for three hours, and we do have a lot to talk about today. One of the things we'd like to get straight to, though, is what you see happening in the economy right now. We've been talking to you for some time about what you see as some significant problems in the economy. And, from your perspective, have things gotten any better? Have they gotten any worse?

BUFFETT: No, they've rippled out some, and that's what you'd expect. So the excesses in credit, the deleveraging that was required, the weak credits that are exposed, all that is--we're seeing manifestations out as the ripples go out, and I think I said one time that, you know, you only find out who's been swimming naked when the tide goes out. Well, we found out that Wall Street has been kind of a nudist beach. There's--it's just one discovery after another of firms that either didn't know what they were doing or that did things that they shouldn't have knowingly. And all of the troubles have not been revealed the first time around, usually, so there's considerable disillusionment that's set in in terms of are these guys telling us the truth now or maybe they just don't know what the truth is. So all of that's having an effect, and what we're seeing in business, in our retail businesses......certainly, anything to do with housing is even a further slowing down. I mean, June and July, both in terms of credit experience with people that first got into trouble of house payments and now on credit card payments and so on. And retail trade, it's not over by a long shot. (two of the last 3 crises were due to over leveraging primarily, if it wasn't for the geared bets, a collapse would not have mattered that much... we should pay more attention to other forms of geared bets such as futures, options or just plain leverage cause I bet you thats where the next crisis is going to come from.. Buffett did say before that derivatives are the weapons of financial mass destruction before)

CNBC: If you imagine where things will go with Fannie and Freddie, and you think about the regulators, where were the regulators for what was happening, and can something like this be prevented from happening again?

BUFFETT: Well, it's really an incredible case study in regulation because something called OFHEO was set up in 1992 by Congress, and the sole job of OFHEO was to watch over Fannie and Freddie, someone to watch over them. And they were there to evaluate the soundness and the accounting and all of that. Two companies were all they had to regulate. OFHEO has over 200 employees now. They have a budget now that's $65 million a year, and all they have to do is look at two companies. I mean, you know, I look at more than two companies.And they sat there, made reports to the Congress, you can get them on the Internet, every year. And, in fact, they reported to Sarbanes and Oxley every year. And they went--wrote 100 page reports, and they said, `We've looked at these people and their standards are fine and their directors are fine and everything was fine.' And then all of a sudden you had two of the greatest accounting misstatements in history. You had all kinds of management malfeasance, and it all came out. And, of course, the classic thing was that after it all came out, OFHEO wrote a 350--340 page report examining what went wrong, and they blamed the management, they blamed the directors, they blamed the audit committee. They didn't have a word in there about themselves, and they're the ones that 200 people were going to work every day with just two companies to think about. It just shows the problems of regulation.

CNBC: That sounds like an argument against regulation, though. Is that what you're saying?

BUFFETT: It's an argument explaining--it's an argument that managing complex financial institutions where the management wants to deceive you can be very, very difficult. Or even when the management doesn't know what's going on, and--just take Bear Stearns. Bear Stearns had--I read it, anyway--750,000 derivative contracts. Now, you know, I could clone Albert Einstein, you know, and--many, many times and have him work 12-hour days for me and he would not be able to keep track of what's going on in an institution like that. It's--the ones that are too big to fail may be too big to manage, in some cases. And they're particularly difficult to manage if they're promising Wall Street and their investors that they're going to do things that can't be done.

CNBC: What would be the best investment to hedge against the upcoming debt crisis?

BUFFETT: Yeah. Well, I would say I don't think there's going to be an upcoming debt crisis, but if you believe that fiscal activities that the government will get out of control and that we will get on a situation where the debt skyrockets, you will have, obviously, you'll have inflation--significant inflation. No government likes to pay back its debt in dollars that are equivalent to the kind they took in. The best thing you're going to have is develop your own talent. I mean, if you're the best doctor in town, if you're the best teacher in town, if you're, you know, the best salesman in town, you'll do well no matter what the currency does. (No debt crisis to Buffett, however he has closed out all his short-dollar bets mainly because the US monthly trade deficits have shifted substantially, imports have dropped significantly while exports had been steady, while that is not the preferred strategy, it helps)

CNBC: If you take a look at what's been happening with the Federal Reserve, with the challenges they've been facing, what kind of job, what kind of ratings would you give the Federal Reserve up to this point?

BUFFETT: Well, I--I'm inclined to give anybody that takes on a tough job like that a pretty good rating. I mean, they get the toughest problems of the world thrown at them. And in my job, I wait for easy pitches. I mean, I--you know, somebody can say Microsoft at 27 or General Motors at 10 and I don't have to swing. I--there's no called strike in my business. So I wait--I could wait a year and get one pitch I like and swing. And so I wait for the easy ones. And in the Federal Reserve position, you have to take on the toughest problems. There are no obvious answers, there's trade-offs. And when I--when somebody that's very bright, very public-spirited takes on the job, I'm disinclined to ever criticize.

CNBC: Do you think the Federal Reserve has gotten inflation under control? Do you think that they've focused a fair amount on the economy?

BUFFETT: No, they've got a tough problem. I mean, with these dual goals of essentially stimulating growth and at the same time containing inflation, they're in direct conflict. And the temptation is, since the lack of growth is apparent today and the inflation tends to kick in later on, to ignore the inflation aspects. It's a very tough balancing act and it can't be done perfectly. And like I say, I couldn't do it perfectly and I don't think anybody can, but I admire the people that take on the job. I admire Bernanke, I admire Greenspan. That doesn't mean I think they were always right. It's--I think they're thought to have more power than they really do have. I mean, Ben Bernanke does not have any magic wand that's going to create--enable people that have borrowed too much money on their homes or people who've lent unwisely or the banks that are too leveraged, that doesn't go away easily.

CNBC: The dollar has gotten much stronger over the last month.

BUFFETT: Right.

CNBC: Is that a trend that you think can or will continue?

BUFFETT: Well, it won't continue if over the next five or 10 years we run very large current account deficits. Now, exports have been doing well lately. I mean, the country is remarkably innovative and resilient. I mean, we are going to export 12 percent of our GDP this year, and in 1970 it was 5 percent. So people who think that America is not in the game are totally wrong. But we have been importing like 17 percent of GDP. If we have that gap and it continues, the dollar over time will get weaker. Not necessarily next week or next month or next year, but it will get weaker over time. You can't run persistent, huge current account deficits for decades and not have consequences.

CNBC: Warren, let's get back to the state of the economy right here and around the globe. When you look around, what do you worry about most when it comes to the economy?

BUFFETT: Well, I don't worry that much in the sense that we've been through lots of recessions in the past, and that the country always comes out stronger, and so I expect--I expect stock markets to go down from time to time. I expect there to be uncovered--I expect that we will uncover credit mistakes. I expect that we'll have recessions. But I also expect, and I'm totally convinced, that your children will live better than you and your grandchildren will live better. So I don't--I don't get upset about, day-to-day, what's happening in the market. It may offer--in fact, it does offer chances to buy things more attractively. I mean, if I go to a supermarket and things are on sale, I feel better.

p/s photos: Angela Zhang Shao Han